"For all I've created returns unto me,
From dust were ye made and dust ye shall be."
-Paul Simon
In their pursuit of value, business leaders and investors essentially place bets about which uses of capital will generate the highest return. The best way to understand this is the Growth-Share Matrix, originally developed by BCG. The matrix plots market growth rate on the vertical axis, and market share on the horizontal axis. It provides an intuitive way to understand what decision-makers are thinking about when they “place bets”. The matrix creates four quadrants:
High Growth, Low Share (Question Marks)
High Growth, High Share (Stars)
Low Growth, High Share (Cash Cows)
Low Growth, Low Share (Dogs)
Said another way, market growth rates represent value created in the market, and market share represents value captured by the business. This allows businesses to evaluate potential return across different opportunities. As those bets move from quadrant to quadrant, decision makers try to allocate capital accordingly. All else equal, businesses are constantly trying to:
Invest capital in successful “Question Marks” and “Stars”
Generate capital from “Stars” and “Cash Cows”
Divest capital from failing “Question Marks” and “Dogs”
This represents the business life cycle.
The business life cycle also ties into another concept that is critical for business investors and operators to understand. In her book, “Technological Revolutions and Financial Capital,” Carlota Perez defines financial capital (FK) as the equity and debt owned by investors, while production capital (PK) refers to the tangible assets that financial capital owns. Or, if you’re Peter Drucker, the equity in the shoe business vs. the raw materials, shoe factory, and completed inventory.
Perez’s insight is that there is a predictable relationship between FK and PK. In the beginning of a new revolution, FK allocates resources to the next big innovation in search of high returns (we could call this a high-growth area with an uncertain future, a “question mark”). To do so, FK decouples from PK, divesting capital from slower growth, more mature markets (e.g., “cash cows”). This rush of capital inflates asset valuation in the new market, creating an early bubble and subsequent crash. Some of those “question marks” turn out to be flashes in the pan while others weather the bubble and coalesce into durable, high-growth opportunities (“Stars”). As those markets continue to thrive, FK and PK recouple, with PK in charge. Down the road, as market growth stagnates, FK and PK start to uncouple again, with FK searching for the next big innovation. Capital is indeed the “dust” of economic activity.
We could easily substitute the terms “investor” and “operator” for FK and PK, respectively. To maximize the value generated in this symbiotic relationship, both roles need to understand the business life cycle and predictable flow of capital.